The California Franchise Tax Board (FTB) may determine that an out-of-state business is subject to California tax if the business has enough of a connection with the State of California.  The FTB is a taxing agency that has taken aggressive positions against businesses that have even minimal contacts with the state.  However, the Federal government has provided a saving grace for some businesses in Public Law 86-272 (codified at 15 U.S.C. §§ 381-384) (“Public Law 86-272”).

Public Law 86-272 generally prohibits a state from imposing a net income tax on the income of a person or company derived within the state from interstate commerce if the only business activities within the state consist of the solicitation of orders for sales of tangible personal property.  The protection only applies to orders that are sent outside the state for acceptance or rejection.  If the Company accepts the order, the order must be fulfilled outside the state. See FTB Publication 1050.

Sound simple? Well, consider the fact that Public Law 86-272 was enacted in 1959.  The state of commerce has changed dramatically since then.  The growth of e-commerce raises many questions as to how to apply Public Law 86-272 to businesses that solicit customers in the state of California.

In a Technical Advice Memorandum issued by the FTB, Technical Advice Memorandum 2022-01, the FTB provides several different scenarios that can have an impact on the whether the FTB can assert an income or franchise tax against a business.  Businesses need to ask the following questions to determine if they are engaged in business in California:

    1. Do you have any employees in California?
    2. Does your company provide post-sale assistance to customers, such as how to use the products?
    3. Do you provide services for customers in California?
    4. Do you assist customers in applying for jobs?
    5. Do you gather customer information by inserting internet cookies onto the computers or personal devices of California residents?
    6. Do you transmit codes or other electronic instructions to customers for remote fixes or upgrades?
    7. Do you sell extended warranties for your products?
    8. Do you use a third-party marketplace facilitator?
    9. Do you provide a streaming service to customers?
    10. Do you provide a FAQ section on your website?

Do you have a business that has a website or interacts with customers in the State of California?  Are you concerned that your business might be subject to California tax?  Do you have potential compliance issues with the FTB or IRS?

The former IRS attorneys at Holtz, Slavett & Drabkin, APLC regularly assist clients with IRS or FTB audits involving all types of taxes and issues.  We can review your situation and advise you about fixing potential tax problems before the FTB contacts you.  Resolving a tax problem before the IRS or FTB contacts you could potentially result in substantial savings on tax penalties and an out-of-state business may qualify for the FTB’s voluntary disclosure program.  Please contact us at (310) 550-6200 to discuss your situation.

Richard Gano is a Tax Attorney at Holtz, Slavett & Drabkin.  Before joining the firm, Richard was an IRS Attorney in the Office of Associate Chief Counsel (Income Tax & Accounting) in the IRS’s headquarters in Washington DC.  His practice focuses on both federal and state tax matters such as tax audits, litigation, and compliance.